Weekday musings on Practical Preparedness, Saving Money, Good Health, and Current Events.

Monday, September 12, 2011

401(k) Withdrawal Mistakes

“Retirement at sixty-five is ridiculous. When I was sixty-five I still had pimples.”
-George F. Burns (who lived to 100)

If you are contributing money to a 401(k), congratulations! This is a great way to save money for retirement and reduce the taxes paid. But putting the money into a 401(k) is just half the battle. You must be extra careful when taking money out of the 401(k) to avoid tax penalties.

1. Leaving before you are vested.
My company supports profit sharing but I don't get to keep my full share until employed for five years. Your company may have similar restrictions on matching contributions to your 401(k).

2. Not doing a direct rollover.
When I joined my current company, the new investment advisor was eager to manage the rollover of my 401(k) from my prior employer. This is not something you should try to do on your own. If you close out your old account you have 60 to deposit then money in a new IRA or 401(k). Otherwise the government considers it an early withdrawal and hits you with heavy penalties of 20-30% or more.

"As a general rule of thumb, don't ever have the check made payable to yourself."

3. Rolling over into higher-cost investments.
You are not required to rollover your 401(k) when you change jobs. It's definitely a good idea if you fear your old company might go out of business or default on pensions. Otherwise compare the management fees on the old plan and the new and go with the lower fees.
In my case the mutual funds were quite different in old and new 401(k). I liked the old funds and decided not to rollover my 401(k).

4. Two required minimum distributions in the same year.
Very tricky. You must take out money EVERY year after age 70½. You can delay your first withdrawal to April 1 of the year after you reach age 70½ but only counts for the prior year and you'll still need to make a second withdrawal for the current year. This double withdrawal could push you into a higher tax bracket.

5. Withdrawals before retirement.
401(k) withdrawals before age 55 will usually require you to pay income tax and a 10 percent early withdrawal penalty. Don't do it! Consider this alternative instead,

"If you roll the money over to an IRA, there are several government-approved ways to spend your nest egg that don't incur the early withdrawal penalty, including unreimbursed medical expenses that exceed 7.5 percent of your income, health insurance after a job loss, college costs, and a first home purchase up to $10,000."

Bottom Line

Be careful with your retirement nest egg. Know the rules about the right ways to take money out of it.